CMA Study Group

cost of capital

  • 1.  cost of capital

    Posted 23 days ago
    A recent leveraged buyout was financed with $50M. This amount comprised partner's equity capital of $12M, $20M unsecured debt borrowed at 7% from one bank, and the remainder from another bank at 8.5%. What is the overall after-tax cost of the debt financing if you expect the firm's marginal tax rate to be 33%?


    ------------------------------
    Syed Yousuf Jamal

    ------------------------------


  • 2.  RE: cost of capital

    Posted 23 days ago
    5.17%

    overall before-tax cost of the debt financing (average cost of financing 38 Million which is 50 million minus 12 Million by equity)  = (20 X 7% +18*8.5%)/ (20+18) = (1.4+1.53)/38 = 7.71%
    overall after-tax cost of the debt financing  =  7.71 % X 67% = 5.17%



    ------------------------------
    Mathew John
    Supervisor
    Al Maha Petroleum Products Marketing Co SAOG
    Not Specified
    Oman
    ------------------------------



  • 3.  RE: cost of capital

    Posted 23 days ago

    5.17%


    the question is asking for the after tax cost of debt financing only. The debt financing portion is 38M. The weight is as follows

    29M = 53.63% ( 29/38)

    18M = 47.37% (18/38)

    after tax cost of 29M = 7%x(1-33%)x52.63%= 2.468%

    after tax cost of 18M = 8.5%x(1-33%)x47.37%= 2.698%


    add the after tax cost of the two debt components will result 5.166%. Rounding off to 5.17%



    ------------------------------
    Sunil Divakaran
    Accountant
    DUBAI
    United Arab Emirates
    ------------------------------



  • 4.  RE: cost of capital

    Posted 23 days ago
    Hi dear,

    Not sure how you're calculating 29M, please elaborate

    Regards,
    Zubair

    ------------------------------
    Muhammad Sarwar
    Analyst
    Al Jubail
    Saudi Arabia
    ------------------------------



  • 5.  RE: cost of capital

    Posted 23 days ago
    Sorry, it was a typing mistake. I said the total debt portion is 38M, but instead of 20M, I erroneously put 29.

    Sent from my iPhone




  • 6.  RE: cost of capital

    Posted 23 days ago
    I believe the answer is 5.17% as follows:

    20M @ 7% and 50M – 12M – 20M = 18M @ 8.5%
    Weighted average pretax cost of debt = 7(20/38) + 8.5(18/38) = 7.71%
    After-tax cost of debt = 7.71% (1-.33) = 5.17%

    The part of this MCQ that I am unsure about is the cost of the equity capital. I can only assume
    that the word "partner's" equity capital in some way means that the assumed cost of that
    equity capital is zero.